As M&A lawyers in the US know all too well, material adverse change (or MAC) clauses became a popular feature during the post-crisis recovery years. But after a slight dip in popularity when economic conditions began to stabilize, these clauses – which are a way for buyer and seller to allocate risk between signing and closing in an acquisition – are now making a reappearance in more private equity deal agreements.
Buyers like MAC clauses to justify not completing their deals because of adverse events. In large part, buyers often succeed in renegotiating deals when they execute a MAC clause because no one wants to drag the issue out in court, and buyers are careful to only cite a MAC clause in clear cases.
Which brings us to recent UK court case Grupo Hotelero Urvasco S.A. v Carey Value Added S.L.. A MAC included in the loan agreement was asserted by Carey. Under the agreement, a material adverse change could be triggered by the “financial condition” of the group. Draftsmen will immediately notice the MAC clause did not include broader language such as the words “business”, “assets” or “prospects”.
What is very interesting to private equity stakeholders is that the UK court had to decipher the true meanings of both “financial condition” and “material adverse change” and gave rare and detailed guidance on how to interpret a MAC clause. Four points are particularly illuminating, and appear to align the courts in the US and the UK:
1. It was argued that the term “financial condition” was a general phrase with no inherent limitations. However, the judge in this instance held that the term “financial condition” should be construed narrowly, starting with an assessment of a company’s financial statements. If other factors (such as the company's prospects in the market) were to be considered, then these could be expressly drafted into the MAC clause. Phrasing of the MAC clause, with the inclusion of the words “prospects,” or “business condition” would give a buyer a better hook to litigate.
2. The court held that a change in financial condition should be judged by reference to the group’s ability to meet payment obligations under the agreement and that this ability would have to be “significantly” affected in order to constitute a MAC.
3. More troublingly, the court found that if a party was aware of a particular state of affairs (or aware that something was likely to occur), then it will have taken to have entered into the relevant contract despite the existence of that particular state of affairs (i.e. a party may not rely on pre-existing circumstances which it knew about to trigger a MAC). It is difficult to advise on the limits of this principle, but acquirers who are aware of adverse factors when they sign a sale and purchase agreement should beware.
4. The court held that in order to be material, a change must not be merely temporary. This is consistent with the approach taken in the US courts in relation to MAC clauses where MAC events need to be “durationally significant”. Delaware courts, the place where most of these cases have been litigated, require a MAC to be “significantly durational” in impact and have never found a MAC.
The case suggests that the English courts are more aligned than ever to the US law in the court’s interpretation and the high hurdle to exercising a MAC.
Given the alignment of laws, it is difficult to understand why the market norms regarding use of a MAC clause vary so much between UK and US M&A deals. US deals frequently include MAC clauses (indeed US attorney's may argue that the stock purchase agreement is one big MAC clause) whereas it is very rare indeed for UK deals to include a MAC clause. Perhaps the answer lies in the low antitrust thresholds in the US leading to more frequent use of conditions in stock purchase agreements, or in the stronger competition for assets and adverse position by (amongst others) the UK Takeover Panel to MAC clauses in public transactions in the European market. In any event, there is no intellectual reason for the differences in market norms (which are propped up by lawyers!), when the laws themselves are so similar.
Andrew Wingfield is a London-based M&A partner with SJ Berwin. He can be reached at email@example.com.